Does saving stimulate the economy more than spending?

When the 2008-09 financial crisis hit, my husband and I were debt-free and building our savings. We were proud of what we'd accomplished, and I used to stare at our savings balance with a smile after every payday.

At the time, all I seemed to hear was that we Americans had to spend our way out of a recession, that spending was the key to growth. Besides $862 billion in emergency government spending, everyday joes and janes were encouraged to spend through home-buyer credits and programs like Cash for Clunkers. (This wasn't unique to the current administration, either; the former administration encouraged Americans to “go shopping,” as well.)

Some people say these programs were a success — that Americans are eager for their government to tell them what to do. Others believe that spending is what led to financial disaster in the first place, and more spending isn't the answer.

You know what? I honestly don't care. I'm more focused on my personal economy. My husband and I made great headway with our personal finances, and we aren't about to stop and jeopardize our future by buying a new car or a flat-screen TV. We have goals, and we're set on hitting them. Someone else is going to have to buy those cars and houses, because we're focused on building our financial future.

But a recent article in Fortune, “The Naked Stimulus: Why Savings Stimulate More than Spending,” piqued my interest, and I came away with a different understanding of why some people argue that spending our way out of a recession doesn't work.

Writer Shawn Tully explains that using basic economic math, you can't borrow from the savers (the taxpayers) to give to the spenders (the government) and expect that to change the GDP. Tully writes:

All savings are spent…GDP measures all spending on all the goods and services that America produces. Savings translate, dollar for dollar, into a major component of that total spending: investment. All the money that the administration successfully moves from savings to consumption simply channels one type of spending to another, in precisely offsetting amounts. It's like filling a swimming pool from one end, and draining it from the other end. The level doesn't change. Nor does GDP change when the government drains investment to lift consumption.

How do savings translate into investments? When we save money, most of us don't hide it in a jar on the top kitchen shelf. Sometimes we buy stocks, which provides companies with money to expand. Sometimes we deposit our money into savings accounts or buy CDs, which the bank lends to corporations or to the government through the purchase of Treasuries. Basically, the money is spent whether you buy a flat-screen TV or deposit it into a high-interest savings account. Even when banks tighten up on lending, they still invest in Treasury bills to earn interest.

The Exception to the Rule

Tully concedes that there's one situation where borrowing could raise the GDP, a situation that he says influenced the theories of British economist John Maynard Keynes. During the Great Depression, when Keynes formulated his theories, people didn't trust banks, so they kept cash in safes or under the mattress. This meant the money sat outside the system, so the federal government encouraged the hoarders to buy Treasuries.

But that's hardly the situation we're in today, where most people keep all of their money in the banking system, and most deposits are insured.

Tully hypothesizes that had the government not intervened by borrowing money, the redirected money would have gone elsewhere:

Two other components of GDP would have to be larger to offset the almost $900 billion in spending and borrowing. First, private investment would be higher, because of the bigger pool of savings, a great sign for the future…Second, the U.S. wouldn't have to borrow nearly as much from abroad. As a result, the dollar would be lower versus other currencies, reflecting its true value.

Hence, imports would be more expensive, and our exports far more competitive on the world markets. The rise in exports would help offset the hit to GDP caused by lower consumer spending. Bigger investment and exports on a tear? That's certainly a good alternative to the results of the stimulus.

Tully believes it's possible that our current situation would be the same, but the outlook would be better for our economic future. What do you think of the theory of spending out of a recession versus saving to stimulate the economy?

J.D.'s note: Though we generally try to steer clear of politics at GRS, that may be tough today. This topic is inherently political. All I ask is that during this discussion, you be respectful of each other. Debate is great, but please leave aside the name-calling and gross generalizations.

More about...Economics

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rick@rickety
10 years ago

Spending is not the answer. Spendings cuts should be made so that people have confidence in the dollar. It is vital to have a reliable store of value.

Fat Bob
Fat Bob
10 years ago

I don’t think it’s quite as simple as they made out 🙂

For instance, all savings are not the same. If your savings are invested safe ventures like producing detergent will generate less extra value than if they’re invested in a riskier venture like pharmaceuticals. At the moment, it seems as though people in the US are favoring safe investments such as paying down debt and bank savings accounts.

I don’t know where government spending falls on that continuum of risk vs rewards, though.

uncertain algorithm
uncertain algorithm
10 years ago

For the most part, I agree. The exception that I can think of is R&D since some investors won’t touch it due to it being new. But, as a general rule, if the government can spend to stimulate the economy in terms of business, investors can provide the same cash flow if there’s legitimate reasons to invest.

momcents
momcents
10 years ago

To be honest, this whole push to get Americans to spend more just doesn’t make sense to me. We were berated for our piddly savings rate and buying more than we could afford as causing this crisis to begin with.

I think we’d be much better off if we went the route of saving to stimulate the economy. I’d like to think I’m doing my part, as my household is now at a 50% savings rate.

Steve
Steve
10 years ago

A dollar saved in a bank account is only spent if someone borrows it from the bank. The Fed has lowered rates to historical lows trying to get people to borrow that dollar. I have seen from personal experience that companies act just like individuals – spending money like water when times are flush, and cutting to the bone when times are lean. It is at least conceivable that the only entity capable of spending during lean times is the government. (Unfortunately they seem to have adopted a policy of spending during flush times and spending even more during lean… Read more »

Will
Will
10 years ago

The Forbes article doesn’t make much sense on the face of it. The author’s premise is that the four segments of the GDP (government spending, private investment, consumer spending, import/export) are necessarily in equilibrium so that if the government increases spending, the other three segments decrease by the same total amount. If that were true, though, GDP would never increase (or decrease), which obviously isn’t the case.

I’m always leery when someone talks about proving something with “basic economics” since there’s nothing basic about it.

J.D. Roth
J.D. Roth
10 years ago

I’ve been waiting all week for this post to go live so I could comment on it! 🙂 More than most things, economics baffles me. The older I get, the more I think economists just make stuff up. (I actually use a different s-word when I talk about this normally, but this is a family blog, right?) Maybe “make stuff up” is too strong, but economics isn’t a hard science by any stretch of the imagination. So, what do I think of April’s post? I don’t know. Like most folks, I hate it when government spends for the sake of… Read more »

Stephen Bank
Stephen Bank
10 years ago

I hate to be impolite, but I think this post is a good example of why avoiding politics is a good idea. I love GRS, but this argument doesn’t seem right to me. Tully writes that the old Keynesian wisdom about excess demand for cash no longer applies, but excess demand for financial assets can play exactly the same role. Just think about it, if saving was just as good as spending, why is capacity utilization still so low and unemployment still so high? And why would businesses invest in excess capacity when they already have excess capacity due to… Read more »

Brenton
Brenton
10 years ago

In the post-9/11 recession, people were encouraged to spend more money in order to ward off recession caused by people staying home due to fear, grief, depression, or apathy caused by the terror attacks. However, this caused a misconception that the recession in late 2001/early 2002 was caused by the attacks, when in reality it was caused by the tech bubble bursting and subsequent cyclical decline. Our beloved former president, Mr Bush the younger along with Alan Greenspan, thought the best way out of the recession was to arbitrarily keep interest rates low in order to spend our way to… Read more »

Sam
Sam
10 years ago

I’ve been preaching this for ages as have many financial pundits but the media and the politicians keep getting it wrong. Yes spending stimulates the economony, but saving/investing stimulates it as well in different ways.

Edward - Entry Level Dilemma
Edward - Entry Level Dilemma
10 years ago

“All savings are spent…GDP measures all spending on all the goods and services that America produces. Savings translate, dollar for dollar, into a major component of that total spending: investment.” This is only true if those savings are in fact spent on investment. Since the beginning of the recession, that hasn’t been the case as much as it was in years past. The total money supply is determined by how much bank deposits (savings) are invested. It’s an inverse ratio based on the amount not invested, so that if 90% of deposits are invested, the total money supply is 10x… Read more »

shash
shash
10 years ago

I think economics, in general, can seem and actually is kind of fuzzy because there are so many variables. It’s no easy feat to understand it. I am trying to learn more about it and one of the helpful things (in a basic way) has been the “Planet Money” podcasts that were born out of that “This American Life” story called ‘The Giant Pool of Money’.(http://www.npr.org/blogs/money/ Of late, they did a podcast about stimulating the economy, if it’s working or not and Keynes’ theories in practice (or not in practice). One of the things that this blog, those podcasts and… Read more »

Chris Caton
Chris Caton
10 years ago

Oh dear. I’m sorry, but this is a rather straightforward question regarding macroeconomics, and I’m afraid I have to disagree with both April’s and Forbes’s analysis. First, there’s the question of the GDP. The US government doesn’t merely spend what it deducts in taxes from taxpayers or acquires through treasury notes sold to taxpayers. It also sells treasury notes to foreign debt holders who are not otherwise taxed, and in fact this amounts in a massive portion of our deficit spending. This is government spending that is a “net gain” over consumer spending, pure and simple. Second is the question… Read more »

Rob
Rob
10 years ago

Long time reader, first time poster. . . . The problem with the savings cycle as Tully describes it is that the institutions that should be plowing our savings back into the economy are sitting on them. Banks in general have been stingy to loan, and corporate cash-on-hand is at record levels. Meaning that no matter where we’re stashing our savings — the market or the bank — it’s not making it back into the economy through loans or through hiring. This is why Keynes is still right, and direct spending by the government is still the only way to… Read more »

jim
jim
10 years ago

I certainly think individuals should save more in general and that consumers should not feel compelled to spend our way out of a recession.

I don’t really see how buying Treasuries is going to stimulate the economy especially since the thesis is opposed to government spending.

Do they expect businesses to increase spending during a recession with declining revenues and no incentives? I don’t know any businesses that think like that. During the recession businesses cut back almost entirely and cut payroll. Businesses still seem scared to increase spending or hiring.

Nicole
Nicole
10 years ago

I’m about to go home but I will be brief here. People in the US weren’t saving enough. It is good that they are saving more. We probably don’t want to save as much as the Japanese do, but we’re still a ways from that. Government needs to step up and spend to get us out of a recession (technically we’re probably on our way out, but not in ways that help people). Then they need to pay back what they spent once the economy is going and employment is up again so that our debt can go back to… Read more »

Nancy L.
Nancy L.
10 years ago

Now, I’m *clearly* no economist, but it seems to me that: Saving through investments – Stimulates the economy bc it provides businesses with money to move forward with development, expansion, etc. Spending – Stimulates the economy bc it provides businesses with revenue through the products they produce. Saving through savings accounts – The bank generally uses that money to loan out to businesses/individuals, so once again stimulates the economy. The only thing that doesn’t seem to stimulate the economy is either when people are saving their $$ under their mattresses, or banks are not loaning out money from their accounts.… Read more »

Matt
Matt
10 years ago

The spending vs saving argument has been fairly well covered in most macro economics books. It seems to come out fairly even. buying things helps businesses grow and circulate money to it employees, saving through buying stock or bonds helps businesses grow by being able to get funds for major purchases. Whether you save or invest, someone will use the money to buy something so it all counts towards GDP growth.

Shara
Shara
10 years ago

@JD I’m curious about your statement that the government spending clearly helped during the Depression. Year by year analysis I’ve been seeing recently about unemployment and other vital statistics of the day show that while things took a dive after the market crash, they were on an upward trajectory until the federal government started their myriad of programs and it was then that the situation completely tanked to the levels we associate with that period. While I have my opinions about what the best policy is, one of the arguements that makes the most sense to me with regard to… Read more »

Nicole
Nicole
10 years ago

I want to highlight two comments: @12 Shash– This American Life has been doing a fantastic job explaining the difficult economics of the current recession for several years– how we got into it, what’s going on now. I STRONGLY recommend anyone who wants to know what’s going on listen to them. I find the Planet Money podcasts really basic and have a hard time listening to them, but my husband who doesn’t teach undergraduate economics (and isn’t an economist) loves them. They do have really good real-life examples illustrating basic economic concepts. If you’re not an economist, these are really… Read more »

Nick
Nick
10 years ago

I think a big picture that people are missing is that you should do whatever feels best to you. This is a free country (but not free as in beer, it sure costs enough to live here) – if you want to save 90% of your income and shop at Aldi you have a right to do that. Conversely, if you want to buy a flatscreen TV on credit, you can do that too. It doesn’t matter if you’re buying it because you want to stimulate the economy, keep up with the Jones or just really really want that TV… Read more »

mike
mike
10 years ago

Similar to April’s comment in her post, my preference is to focus on personal finance. I don’t care the impact it has (or doesn’t have) on impacting the economy. I focus on improving my family’s net worth.

@J.D. #7 – It’s likely not a topic for GRS, but I’m curious about the variety of reasons you’re not a fan of military spending. And what you would see as an alternative(s), if any. Budget cuts to the program, or eliminate the entire program? Could be interesting in a discussion.

Clambone
Clambone
10 years ago

The post mistakenly states that the stimulus was $836 billion in government spending. In reality, about $300 billion of that was tax cuts or tax credits. http://www.businessweek.com/news/2010-04-10/obama-says-stimulus-plan-has-provided-160-billion-in-tax-cuts.html I’m sorry to say that Forbes has been pretty openly declaring its allegiance with the Republican party. Just this week, they published as a cover story a seriously error-packed analysis which accused Obama of being secretly motivated by Kenyan anti-colonialism (rather than mainstream center-liberalism). And Steve Forbes’ latest column is illustrated by a Photoshop of Obama’s head on Stalin’s body, talking to Lenin. They have every right to turn the magazine from a… Read more »

AC
AC
10 years ago

JD,

I know you have to do political stuff, but PLEASE do an article on Christine O’Donnell and how she is politicizing her finances.

Saving, if it is being transferred to investment and bonds is definitely stimulating the economy. Unfortunately, businesses are not being very responsive to monetary policy (FED) so we constantly have to look for fiscal policy (Congress) to pull us out of this.

average
average
10 years ago

all the talk about economists…

… reminds of me of something President Eisenhower once said. He said he wanted to find a one-armed economist because in any discussion, they would always say: “on the other hand…”

Flaneuse in DC
Flaneuse in DC
10 years ago

Are we talking about personal/household spending (which I thought was the subject of the original post) or government spending (which the comments seem to address)? On the former — there’s spending on decent stuff, and spending on stupid s**t. I half-jokingly say that I’m going to shift my spending to SERVICES rather than goods: think massages! think music and dance lessons! This also keeps the massage therapists and the instructors in business; they gotta make a living too. When I’m buying Stuff, I try to support smaller producers whenever possible, supporting cottage industries. We will always need to buy some… Read more »

Chris
Chris
10 years ago

This post reminds me of a couple of questions that I’ve had about this whole borrowing to spend our way out of a recession thing. It may simply reflect my lack of understanding of just what constitutes “money” but it seems to me that if I save rather than go into debt that I have future spending power quite a bit beyond what I would have if I bury myself in debt. question 1. If I borrow at 20% (not unusual on many credit cards) to buy a $2000 big screen TV and take 2 years to pay it back,… Read more »

Marcella
Marcella
10 years ago

I am by no means an expert either, but one additional issue to consider is the amount of cash reserves a bank now must carry. I know that banks here in Australia, as well as those in Europe, have all been undertaking “stress tests”, which have basically uncovered the fairly obvious (or after the GFC it seems obvious) fact that most banks do not carry enough cash reserves for the amount of credit they have extended. Many governments are now implementing legislation requiring increased liquid cash. Now, I am truly not a student of econmics, but the way I read… Read more »

Aleks
Aleks
10 years ago

I’m not going to deny that some economists make stuff up, but for the most part there are some basic fundamental things that have stood the test of time, at least since the 1930s, which is a long time in social science theory. It may be a long time in social science theory, but it’s pretty short in historical terms, and just about exactly the period between depressions, historically. If economic theory doesn’t account for the period before the last depression, its value is questionable. Arguably it should account for at least two complete cycles to be considered supported by… Read more »

Jaime
Jaime
10 years ago

I’m saving because social security isn’t enough to live on. I don’t expect the government to take care of me. That’s not their responsibility nor should it be, in fact there are lots of poor Americans in retirement,is the government helping them out? No. So you have to look out for yourself and make sure that you are hitting your saving/retirement goals.

Also spending is what got us into trouble, we just really need to be frugal for awhile. The entire country needs to go back to saving their money.

Edward - Entry Level Dilemma
Edward - Entry Level Dilemma
10 years ago

@25: Chris “question 2. I keep hearing that our economy is dependent on consumption. What else could it be dependent on? Before consumer goods were the basis of our economy, what was and might it be better for the environment etc. if we find some other basis for our economy?” What else could the economy be dependent on? Consumption doesn’t necessarily mean big screen tvs and Big Macs. It means anything that is used. That means food, energy, everything. Money is a tool to facilitate trade. Trade is used for obtaining things we need (or just want). Whenever I hear… Read more »

J.D. Roth
J.D. Roth
10 years ago

@AC (#24)
I’m ashamed to admit I had to google to see who Christine O’Donnell is. (Kris would tell you that she thinks my intentional ignorance of current events is one of my worst qualities. I think it keeps me sane.)

Anyhow, can you point me to some info on her politicization of her finances? I’ll do some digging myself, but could use some help, I think…

Patty
Patty
10 years ago

I agree with April on the point about “personal economy.” I was raised by a family who absolutely did not believe in debt. Nothing would persuade me to lose my safety net on superfluous things. Aside from the political element of this piece, the truth is that there are economists on both left and right who feel that “spending” our way out of this recession does not help the average Joe or Jane. As a bookkeeper, my biggest concern, is that I’m starting to see more clients with very high balances get credit card offers in the mail. I’ve seen… Read more »

J.D. Roth
J.D. Roth
10 years ago

AC, I did a little reading. I’m not touching that topic with a ten-foot pole!!!

Jessica
Jessica
10 years ago

I’m with JD and others in that economics (especially macro) is one of few subjects that I haven’t really been able to wrap my head around. As a result, I have a hard time processing articles like this one and deciding whether I can really accept the conclusion or not. Reading the article, I find myself thinking that if everything in the GDP equation always balances out, how does it ever increase? Also, is raising the GDP really what we’re looking for? Tully states that higher income people are the ones more likely to save, and lower/middle ones more likely… Read more »

Nicole
Nicole
10 years ago

Aleks, you’re getting short term claims mixed up with long-term theory. And at least where I was going to graduate school, everybody knew that the housing market was headed for a crash. They didn’t see how much it was going to crash, but they knew things were out of hand. Everybody knew the dot com bubble was going to burst, too, though that recession didn’t last as long. Everybody also knew that Bush’s tax cuts were ridiculous and were feeding an already overactive business cycle. Greenspan might have thought there was a new paradigm (possibly he was too close, and… Read more »

Norman
Norman
10 years ago

I think our country’s economic problems boil down to one simple thing: We have been importing more than we have been exporting for far too long and it has finally caught up with us.

Jessica
Jessica
10 years ago

I don’t think you had to be an economist to suspect that the bubble was bound to burst, and the housing market was bound to crash. It seems like our innate need for equilibrium led us to doubt such unbridled growth on instinct alone. Where I live in Northern California, it just felt so frightfully precarious, and it just made sense when everything toppled, though it still hurt. Three years ago, a very smart relative in investment banking told us to sell all of our stocks asap, because a crash was imminent. A few months later, his predictions came true.… Read more »

Kris
Kris
10 years ago

A good website containing a rap video that condenses the two economic philosophies: the stimulus plans (Keynesian Economics); and the opposing view Austrian Economics lead by F. A Hayek. I encourage you to view it.

http://www.econstories.tv/home.html

It is the propensity to work, and not the propensity to spend, is the foundation of national income and wealth.

L. Albert Hahn – 20 th century German Economist

David
David
10 years ago

“You know what? I honestly don’t care. I’m more focused on my personal economy.”

Unfortunately, your personal economy exists within the national economy. If the government keeps spending without limits, your savings will be put on the hook to help pay it back — and then your “personal economy” will come crashing down.

50plusfinance
50plusfinance
10 years ago

Norman is right about spending being out of control. We need to cutback the size and cost of government.

Economics is a little bit fuzzy for me to get. So also for the leaders of the government. When there are two competing views of economic theory and one administration interprets it to their own devices, what to do?

Bananen
Bananen
10 years ago

As usual Keynes was wrong and the Austrian School of Economics provides the answer: When people save their money in jars, the supply of money goes down. This leads to a higher value of the remaining money, which means that exactly the same amount of work will be done with or without the jar-money.

Justin
Justin
10 years ago

I’m slow in reading this today, but this is Economics 101. It’s not a matter of what we think of spending out way out of a recession, it’s what works. Things that work in the short run include: – Increasing investment via lowering interest rates. – Print cash. – Encourage spending. There is a problem with the savings argument in the short run: Imagine you’re the governing body of a country with a pop 100,000, all employed by a single firm which provides all necessary and luxury goods and services to your nation. If you say “save your money everybody!”… Read more »

Steve S
Steve S
10 years ago

There is a lot of literature out there about the Depression era and the supposed “WWII boom”, here is a slice (it’s late) but please find some more. Time to get edu-ma-cated.

http://online.wsj.com/article/SB10001424052702304024604575173632046893848.html

Pop
Pop
10 years ago

Scared companies spend much less on new equipment/factories than confident companies. Companies are scared unless they have a consumer to sell to. “If you build it, they will come,” is a much harder to swallow strategy than “The customers are here. Now please build it.”

Antti-Juhani Kaijanaho
Antti-Juhani Kaijanaho
10 years ago

I see there are many good comments discussing the very big misunderstandings in the article, so I won’t go there.

But a note on personal finance versus national economics (or macroeconomics, as it is usually called).

Saving and avoiding debt is good personal finance advice. However, if everyone (or even sufficiently many people) changes their financial behavior pattern at the same time, moving from spending to saving, from indebtedness to paying debt off, the number of people buying (and the dollar value of their purchases) drops. This will cause a (demand-side) recession.

It’s a basic macroeconomic paradox.

Anonymous
Anonymous
10 years ago

I haven’t read the other comments, because I’m afraid that even glimpsing the discussion will make me late for work so I can “fix things on the internet.” The article here implies unfamiliarity with basic economics; the Forbes article obviously grasps that GDP = C(onsumption) + I(nvestments) + G(overnment spending) + e(X)ports – I(mports) but appears to be glossing over a lot of important theory. A lot of macroeconomics is more science than opinion. Asking people what they think about spending, GDP, and economic recovery is a little like asking people to chime in on what proteins we should target… Read more »

Veritroth
Veritroth
10 years ago

Chris Caton is not the right direction. For a quick rebuttal: “Wealth is created not only by putting more money into the system…” No. No. No. Wealth is not created by adding more money into the system. Inflation is created by adding more money into the system, but everyone’s wealth remains the same. Debasing a currency does not make everyone richer. “So if in a given year we can increase how quickly money changes hands, we increase overall wealth.” Wrong again. If I were to give you a piece of advice for $100, then you gave me some advice for… Read more »

MaryL
MaryL
10 years ago

“The bigger issue here is that personal finance and economics are very different topics. Personal finance is mostly about getting your behavior in line with common sense, while economics is a counter-intuitive and technical subject, and it’s full of controversy even among professionals. You shouldn’t try to apply lessons from one field to the other.”

What Stephen Bank said.

MutantSupermodel
MutantSupermodel
10 years ago

You know what I take away from this? Diversify! Too much of anything is never a good thing. I think this works on a micro and macro level (and a moral level too but that’s another story for another blog). That’s why neither political party can get their arms around this beast– they’re just too much one way or another and steer clear of the middle path which is probably the best solution. Of course we should spend. Of course we should invest. Of course we should save. I think the government needs a copy of the Balanced Money Formula.… Read more »

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